A not so rosy take on US BigLaw 2018 performance

Mark opens by observing ‘The most recent Citi Report drew considerable industry attention following its release in December, suggesting the opening sentence of the Executive Summary is the likely reason: “The US law firm industry is enjoying its strongest growth in almost a decade”.

The Report ticked off a slew of positive indices: an average 6.3% revenue growth; 4.3% billing rate increase during the first nine-months of 2018; a 3.3% increase in demand among the AmLaw 50 firms; and gains among both large and small firms.

Uneven Results And Ominous Trends

The Citi Report’s headline-grabbing “strongest growth in a decade” came as welcome news for skittish firms and a surprise to pundits opining when firms’ other white shoe will drop. But as Gilbert and Sullivan cautioned, “Things are seldom what they seem.” A closer look at the Citi numbers reveals that it was a banner year for some firms but by no means all. This is consistent with data from other sourcesindicating a widening fiscal separation between a cadre of “elite” firms and the rest of the pack. While the 6.3% revenue growth of Citi’s surveyed firms is impressive, it is offset by the 5.9% increase in firm costs. That yields a miniscule 0.4% increase in profits. Longer collection cycles, declining realization, and “dispersion”— the near even split between firms that see demand increase and firms that see demand decline year-to-year– tell a different story than the Report’s bullish headline.

The Citi Report also revealed several ominous trends—the challenge of hiring lawyers/legal professionals with new skillsets–“not just legal expertise;” talented associates opting out of the partnership gauntlet; an aging partnership whose retirement will create a “capital gap;” succession issues; a dearth of internally-promoted partners and reliance on risky lateral bets to spike profit-per-partner (PPP). These are all indications that most firms are focused on short-term performance, not investment in long-term sustainability and transformation to a client-centric business model.

Equity partner headcount declined by 0.3%, a continuation of a seven-year trend where equity partner numbers have remained flat but leverage (non-equity billers) has increased. That’s a good way to prop up PPP but not a winning long-term strategy. Technology is replacing brute force labor for many “legal” functions, and law firms are no longer the default provider for all “legal” work. BigLaw is confronting intensifying competition—not only from other firms, including smaller ones, but also from in-house departments, the Big Four, and other law companies.

Legal providers in today’s market must satisfy customer needs and deliver scalable, efficient, cost-effective, and measurable solutions that yield profit. This contrasts with the traditional law firm partnership model where profit emanated from a pyramidal structure whose foundation was billable hours and high rates– not outcome and value. Most law firms have yet to make the transition. Legal delivery is no longer about high-priced firm lawyers billing countless hours to solve legal challenges. It’s about integrating necessary expertise and leveraging it with appropriate resources—technological and “right-sourced” human ones—to solve complex business challenges efficiently, cost-effectively, holistically, and measurably. This is legal delivery in the digital age.

Citi reported that equity partner turnover– lateral hires, defections, and “de-equitization”—was the highest in five years. This coincided with more laterals achieving equity status than internal promotions, another blow to firm morale and a further impediment to succession planning. Citi projects this pattern will continue; “we believe that is unlikely that there will be an imminent return to law firms clearly favoring promotions.”

All this confirms that most firms are pursuing a “future is now” approach designed to prop up short-term PPP. That strategy typically ignores—or pays lip-service to—the increasingly urgent challenge confronting all firms: how to narrow the growing divide between what clients want and what firms currently sell. That requires equity partners—a majority of whom are nearing retirement—to reinvest in the firm’s future and “leave money on the table.” Absent a residual financial incentive to do so, that is a tough ask.

This begs the question: where will firms’ next generation of leadership and talent come from and will it have the new skillsets, diversity, and resources—structural, financial, human, technological, process, cultural–to be competitive in a rapidly evolving global marketplace? Traditional partnership firms must commit to a client-centric model, and that’s not just a catch-phrase. It is a difficult, painful, and staged process that requires a commitment to structural, economic, and cultural change. Diversity is an integral element of firms’ cultural change. They must commit to diversity in hiring, training, retention, leadership, client stewardship, and other key management and operational components. The firm must also promote a collaborative ethos that advances client interests, not the firm’s internal pecking order and origination credit.

The Citi data reveals that firms will soon experience a changing of the guard. If present demographics hold, Citi projects that approximately 61% of partners will be at or approaching retirement in eight years. That will create an acute “capital gap” and foment internal friction over who will pick up the financial slack and whether it’s a good investment. It will also have a chilling effect on young talent and recruitment.

Firms are already confronting a talent gap that has two main components: (1) a dearth of young candidates with project management, data analytics, business and other skills required to augment “knowledge of the law;” and (2) Citi’s finding that “a significant proportion of associates do not want to become equity partners.” The promise of partnership was long the carrot firms used to attract and retain talent. The combination of fewer internal promotions to partnership and a disinclination of many younger lawyers to stay-the-course will cause firms to scramble—and pay a premium for– capable talent. It’s no longer a secret that the traditional firm partnership model is showing stress cracks, and talented legal professionals have alternatives to law firms.

What About The Competition?

Law firms are no longer competing solely with each other for clients and talent. The well-documented migration of work in-house and to so-called “alternative legal service providers” (ALSP’s) is another ominous sign for firms, particularly those with undifferentiated brands (read: most). Many corporate departments already operate differently than firms—they have corporate models; dual roles—corporate guardians and business partners; different performance metrics–output, not input; closer alignment with the business; more integration with others in the legal supply chain (e.g. their internal legal operations teams and/or outside service providers, the Big Four, law companies, niche providers); and financial alignment with the consumer (stock and other corporate remuneration). In-house departments tend to be more collaborative than firms because sourcing work to the right provider is a win, not a (short-term) loss of revenue. The same can be said for leading ALSP’s whose genesis and growth are tied to law firms’ languid response to changing legal consumer demands, new delivery models and tools, and the growing complexity and speed of business. Firms are largely making internal changes that impact their short-term bottom line.The competition is focused on what clients need and how they can most efficiently, cost-effectively, measurably, and impactfully deliver it.

Clients Are Calling The Shots Now

Law firms pay lip service to “client-centricity” and “innovation,” but the Citi Report’s findings suggest most are more focused on short-term preservation of PPP and less on systemic changes required to provide legal consumers with what they need. Law firms long dictated the terms of engagement to clients. That’s changed. Legal delivery is no longer synonymous with legal expertise, most firms’ stock-in-trade. It is about solving multi-dimensional, business challenges that require legal, business, process, technological, data-driven, collaborative solutions at the speed of business. Firms remain “law-centric” in a digital age when tech and process-enabled, client-centric legal business providers that use data, leverage expertise, and right-source tasks are transforming legal delivery. No matter the name one attaches to such models, they are—and will continue to—garner increased market share from static traditional partnership firms.

Conclusion

The Citi Report affirms that some firms continue to prosper, even as many are experiencing unaccustomed “dispersion.” The trend lines suggest that firms’ short-term approach will continue to erode internal stability, impede structural and economic reform, and discourage investment in resources required to better align with and satisfy legal buyers. That’s the real headline.

Mark Cohen

Author

Mark Cohen is a lawyer, law professor, legal innovator and strategist, and founder of Legal Mosaic.

Mark says of himself “I write about changes in the global legal marketplace”.

This post was first published by Mark Cohen as A Banner Year For Law Firms? A Different Take On The 2019 Citi Report in Forbes on January 7, 2019.